Terminology You Need to Know to Successfully Raise Capital in 2020
When the economy began to feel the effects of Covid-19 in March of this year, many technology companies held off from launching and fundraising. Conferences and VC summits were cancelled, and there was a sentiment of uncertainty in the air. Six months into this “new normal” we are witnessing a return of networking events and investment opportunities as companies and investors alike are embracing the new ways of doing business: an environment where all stages of investment, from networking, to pitches, to signing term sheets and performing due diligence, is conducted fully virtually. In this article, we list some of the top terms you need to know when raising capital this year, especially if you are seeking investment for the first time, as well as some recently announced Venture Summits where you can put this information to use.
You’ve got a great product, you’ve found product-market fit, and now it’s time to raise some money. The business of raising capital is intimidating enough without feeling lost in the throes of negotiations, so it’s time to brush up on your vocabulary. We’ve compiled a list of useful terminology to help you before you write your signature on the dotted line.
These are individual investors looking to get in early at high risk, high reward – as such they’ll often be looking for a large percentage of the company. Unlike a venture capitalist, he or she is investing their own money instead of a fund’s money, and the high level of risk involved on their part can make negotiations take time.
This is when an entrepreneur or an investor doesn’t seek outside funding for financing. If a startup is funded by the owner’s own money, that’s bootstrapping. This frees them from having to pay interest to a bank for a business loan or give a portion of the profits to an investor.
How long will my investment last? The burn rate is one of the first metrics an investor will ask for. The gross burn rate is simply the operating costs per month, whereas the net rate includes revenue in the calculation. By dividing the total money in the bank by either rate you get the number of months remaining before going broke. If revenue is unpredictable the gross rate is the worst case scenario, but if revenue is growing the net rate can show the best case scenario.
A capital table is a breakdown of all of the stockholders’ rights, restrictions, individual investment information such as transfers and sales. It is a tool that holds all financing details for founders to make informed. Over time it grows exponentially more complicated so in larger companies this is usually managed by their legal team.
‘Cash Flow’ is used to indicate the profitability of a company. It takes into account every detail of money moving through the business, giving a better picture of profitability than simply looking at profits. It’s an understanding of where all the money comes in from and goes out to, and what’s left at the end of the period. There are three main areas of cash flow within a business: operations, investing activities and financing activities. Each is calculated individually and provides more depth in the analysis. Finally, the three are added together and the total cash flow is calculated. If total cash flow is positive it is called ‘free’ cash flow. Investors will often determine how risky the buy is by how much free cash flow a business can rely on.
Churn rate is another important indicator of how long your company has to live, especially for SaaS businesses which often rely on subscriptions. Churn is customer turnover – how many customers do you lose per month, or year. You can add 10% more subscriptions monthly, but if you also lose this many your business might be stagnating, thus raising red flags for investors.
Cliff vesting vs. graduated vesting
Startups like to use cliff vesting because of the uncertainty inherent in being a startup. It is a benefits package that incentivizes employees to stay with the company for a fixed period of time. Typically, employees are ‘vested’ gradually over a number of years. The employer provides the employee with assets like mutual fund contributions, or company stocks, on a yearly basis. The employee has access to an increasing percentage of that amount every year, say 20% over 5 years until he or she is 100% vested and can claim that amount on leaving the company. Cliff vesting, on the other hand, withholds any vestment for a longer period of time, and then awards it all in one shot. This way an employee might be 100% vested after 2 years, but have 0% the day before those two years are up. It can be more risky for the employee if the company is bought out, or he is fired, or resigns in those first two years – leaving with nothing to show for it.
Common shares vs. preferred shares
Investors in a startup will usually be looking for preferred shares in a company. This is a way for them to reduce the uncertainty inherent in their purchase by giving them higher priority in the case of a sale or a liquidation of assets. Preferred shares are prioritized when it comes to the payment of profits or assets, where common shares receive whatever is left.
This is a tool for early investors to mitigate their risk. Often investors will offer loans at the earliest stages of a company, before valuation is even a concept. A convertible note allows them to be repaid in share ownership once the company has passed the first stage of valuation, but with an advantage. This advantage can take the form of a percentage discount on the initial share price, or cap the valuation that their shares would be bought at. That way if the company exceeds expectations on the initial valuation, the investor also increases his share in the company.
Crossing the chasm
Author and businessman Geoffrey A. Moore published a book in 1991 called Crossing the Chasm: Marketing and Selling High-Tech Products to Mainstream Customers. He describes the difficulty of shifting from the early marketing success of a product with customers who are willing to take on some risk in buying early, to mainstream success. This especially applies to products that change consumers’ way of life. Moore explains how as a product moves through each stage of marketing, the move from a successful ‘niche’ market to the beginnings of mainstream is particularly tough.
Lots has been theorised about disruptive innovation because everyone wants to either be one or predict what the next one will be. True disruptors target a product or service that is being provided in a usually expensive or limited way and provide consumers with a simpler, cost-efficient, and/or accessible alternative. Usually these innovations start by taking the crumbs at the low end of an existing market and are often not taken seriously by market leaders until it’s too late, and they are suddenly the mainstream. Examples might be streaming services vs. video rental, smartphones vs. laptops or print vs. digital.
When you’re looking for investors, this is when you tell them about all the money they’re going to make and how they’ll get it. When an investor goes into a startup he needs to know how he’ll be getting a return, i.e., sell his equity – startups don’t simply start giving money away. Typically these happen through merger with another company, being bought out by a larger company, or by going public with an IPO.
Iteration (Iterative Process)
The idea behind using iteration in startups is to start the feedback loop early on in the development process in order to form a positive relationship with your customers and use their input to accelerate development. This might mean launching before having a complete product or seeking investors in order to start those conversations and feed their comments back into the product.
There can be many reasons to shift directions as you develop your product. Perhaps customer feedback has shown that there would be greater demand with an added element you hadn’t thought of, or there have been changes in the world that require you to adapt your product, or it simply doesn’t work. The term is sometimes used to indicated a positive shift in the company, and sometimes to under-state a failure.
It’s important for investors to know which valuation they are buying into. P-Value of a startup prior to an investment/value of a startup upon funding.
Typically the run rate is a revenue metric calculated by multiplying one quarter’s results by four in order to predict future revenue. It is a simplistic metric that can work for startups showing their first signs of profit but can sometimes be used to mislead investors, so they may be wary of it. There are many reasons for one quarter to be an outlier, so run rates are often accompanied by a disclaimer.
Now what better place to use these terms than at a venture summit that you can attend from the comfort of your home office? Check out the list of venture summits found below:
“Come meet, interact and network online with more than 1,300 VCs, Corporate VCs, angel investors, industry execs and founders of venture backed, emerging and early stage companies at the prestigious Venture Summit Virtual Connect 3 being held virtually on November 17th-19th 2020.
Whether you’re a startup seeking capital and exposure, or an investor seeking new deals, Venture Summit Virtual Connect 3.0 presented by youngStartup Ventures – is the event of the year you won’t want to miss.
A highly productive venture conference, Venture Summit Virtual Connect 3.0 is dedicated to showcasing VCs, Corporate VCs and angel investors committed to funding venture backed, emerging and early stage companies.”
Each Startup will have 7 minutes to share their pitch deck with the virtual audience and panel of judges. The winner will be decided by the end of the event following panel feedback.
If you’re an entrepreneur, an investor or just a big fan of the competitors – make sure you register and tune in to learn more about each company, and hear from the judges on how they all did – this is an educational event like no other!”
“The Canadian Export Challenge (CXC) has historically been a series of one-day Global Accelerators across Canada for startups and scale-ups who are thinking about, working towards, or are already exporting their products or services.
This fall, join Startup Canada in collaboration with UPS, Export Development Canada, and the Trade Commissioner Service, along with Mastercard and Scotiabank to become export-ready, connect with the trade and global growth system, and to gain global exposure through a series of digital events powered by Google.”
To explore more of our content, visit the Alacrity Canada Blog page where you’ll see Alacrity’s podcast on early-stage tech investment Between 2 Term Sheets, and our cleantech podcast series, Cleantech Talks. Follow us: @alacritycanada on LinkedIn, Facebook, Twitter and Instagram for the latest in tech news, and information about upcoming events.
Alacrity Canada is a venture builder that supports driven entrepreneurs. We help create thriving companies & connect them to our global network of expert investors & mentors.
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